BE/U4 Topic 6 Pricing under perfect Competition
Earlier economists took one sided view of the problem of price determination. It was only Dr. Marshall who gave equal importance to demand and supply.
He pointed out that it was useless to argue whether it was demand curve or it was supply curve which was more important.
He pointed out that a market is composed of two parties, viz. the buyers and the sellers and both of them are equally important. In the absence of anyone, price cannot be determined. He, therefore, argued that both buyers and sellers are important in the market and, both demand and supply curves are important for determining the price of a commodity.
Marshall compared the demand curve and the supply curve to the two blades of a ‘pair of scissors’. He pointed out that blades are needed to cut cloth. If a person wants to cut with a single blade it will be impossible.
He further stated that at different occasions the upper or the lower blade becomes more or less important. According to him, it is a matter of time that at some moments it is the demand curve and at some other moments it is the supply curve, which is more important.
In the same way, Prof. Stonier and Hague has correctly remarked, “The only really accurate answer to the question whether it is supply or demand which determines price is that it is both.” The price which will come to prevail in the market is one at which quantity demanded is equal to quantity supplied. The price at which quantity demanded equals quantity supplied is called equilibrium price.
Factors Affecting Price Determination:
(i) Total Demand
Demand does not mean the amount of a commodity, say, tea, which people need, or would like to have, but the effective demand, the amount which people are willing to buy at various prices. Every unit of a commodity has a demand price, the price at which that unit finds a buyer.
Other things being equal, a fall in price leads to an increase in quantity demanded and rise in price leads to reduction in quantity demanded. A fall in the price induces the existing buyers to buy more and attracts new customers. It may also have substitution and income effects. The quantity demanded thus varies with every change in price.
(ii) Total Supply
Supply means the quantity offered for sale by producers. Thus the supply of tea does not mean the actual stock of tea; it means the amount of tea which the producers are willing to put on the market at various prices.
Every unit of a commodity has a supply price-the price at which it is offered for sale. Other things being equal, a rise in price leads to an increase in the quantity offered for sale, and a fall in price reduces the quantity offered for sale.